My investing philosophy mostly centers around the Value discipline and GARP- Growth at a Reasonable Price.
This blog includes commentary on market conditions as well as fundamental analysis of specific companies.
Graduated from Rhodes College with a degree in Business with concentration in Finance & Marketing.
Currently working on obtaining the CFA designation.
Previously worked in Mortgage Trading for a major bank.
Use MS Excel extensively for developing investment models, notably valuation models based on DCF methods.

Friday, July 6, 2007

In Barron’s July 2, 2007 weekly print edition, Mark Veverka gave his analytical opinion regarding Apple’s prospect in the article titled “Fight Apple’s Temptations – Briefly.” Veverka seeks to make the point that the iPhone is not largely important to Apple’s overall business. As the subtitle points out- “It’s the software, Stupid” The author is referring to Mac OS and its software “Boot Camp” that allows users to run Windows and Mac OS simultaneously on a Macintosh machine. He believes that it’s the “Halo effect” of the iPhone that will drive Mac sales, which in his opinion, will have to be robust to support Apple’s current stock price.

While he makes some interesting and solid points, his analytical ability is called into question when he makes some indisputable, gross errors. It also makes one wonder if there are editors or fact checkers that review the work before it is published so that Barron’s reputation won’t become tarnished.What I am referring to is the Veverka’s statement appearing in the second section of the article:

“As important as iPhone’s launch is, computer sales will be key to the stock’s maintaining it’s upward trajectory will into 2008.”

I do not necessarily disagree with that statement. Further Veverka adds:

“To put things into context, if Apple sells 10 million iPhones in 2008, that would add only 500 million in revenue.”

Hold up, let review our math from 1st grade, Ok if 10 million times 5 is 50 million, and 10 million times 50 is 500 million, then 10 million times the $500 selling price of the iPhone has to be 5 billion, not 500 million as the author stated. Ok, maybe it’s a typo. However, when he further says:

“Or 2% of its 21.6 billion estimated total (2008 Revenue). Thus, a big part of the story is the Mac.”

The aforementioned string of incorrect statements leads me to believe that it’s not just a typo, but very sloppy work. Anybody slightly familiar with Apple knows that iPhone is expected to add 5 billion in revenues and 2.5 billion in profit next year, and It would stand to reason any editor proofing the article would notice those misstatements. I mean after all, why has Apple’s stock been rising the past six months on the tear that it has? Is all the frenzy around the Mac? Uh no. It’s the iPhone, Stupid. Additionally, “21.6 billion of its estimated total”??? Estimated 2008 revenues? Which Veverka incorrectly states 500 million is 2% of? Actually, the consensus sales estimate for 2008 is 29.2 billion from both ThompsonFN and Reuters. For FY 2007, which ends this September, is expected to come in at 23.7 billion. Trailing revenues in the last 4qtrs has been 21.6 billion which is not an “estimated figure.” That’s an actual or historical figure. After seeing the erroneous statements the article, the author, and Barron’s (only to very slight degree) lost credibility in my mind. It’s tough to listen to the Veverka’s points when one has the impression that he has no idea what he is talking about.I must point out that Barron’s corrected the 500 million to 5 billion and 2% to 23% in the article posted online. Yet, the article’s major point is how less significant the iPhone is to Apple’s success than what the majority of people perceive it to be. That’s true if the iPhone is only 2% of sales, but totally ignorant when it’s expected to be a quarter of sales. Thus, the purpose of the article is really lost.Veverka points out that Mac sales will be the key to maintaining the stock’s upward trajectory. I previously mentioned I can agree with that statement, but in a different aspect. Veverka seems to think (since iPhone sales will only be 2% of revenue) Mac shipments will have to bear the heavy lifting. My thoughts are that Mac sales will only be crucial on the margin. To explain, iPhone sales will be a major portion of revenue and also demonstrate the major growth, yet it that forecast is already priced into the stock. For the stock to head higher, Apple must exceed expectations. Since the iPhone expectations are already lofty, the source for upward surprise will have to be from the Mac side which is forecasted to only grow 15% (1.5 billion) next year. To set the record straight, 5 billion (most think more like 6-7 billion) of sales growth next year will be driven by the iPhone; only 1.5 billion of sales’ increase will be attributable to Mac sales. Apple’s stated goal is the 5 billion figure, and they are notorious for low-balling thus Wall Street has revision that number upwards in making their estimates. That leaves less room for an upward surprise in expectations. Yet, the 15% growth rate is conservative, and Apple will easily exceed and mostly likely grow Mac revenue 25% or 2+ billion next year. That will be the source of surprise needed to keep moving the stock and not the majority of the absolute sales dollar growth. In essence, contrary to Veverka’s opinion, the iPhone is largely important since its expected to make up the major portion of sales growth and a significant portion of overall revenues. Even though Mac sales will be a small portion of growth, increasing success is tantamount in keeping and increasing investor’s interest and expectations.

2
comments:

AAPL is recording the revenue (and costs) of the iPhone over 2 years, which is presumably the subscription term with ATT. As a result, the revenue numbers will not jibe with CF numbers. It's conservative, no doubt, but it also explains why during the last call, AAPL only claimed about $5 million in iPhone impact, which was mostly accessories, which aren't subject to this accounting policy.

Barron's corrected Veverka's statement after the original article ran changing 500m to 5B for 2008 iPhone revenues. Obviously that assumes a 500 asp. It's true that Apple is recognizing iPhone revenue over 24 months as they announced on the conference call. Even so, 2008 revenues will probably be around 2B with recognition over 24 months. Actually, I don't agree with Apple's treatment of the recognizing iPhone hardware over 24m since I believe the return policy is at most 30 days. The ATT payments for the revenue sharing of subscription services should definitely be recognized over the life of the contract since those have yet to be used, but the iPhone handset is different. They can be lost, broken or stolen causing the user to have to buy another handset, but the contractual services can be lost or stolen so they will never have to be repurchased. Additionally, if Apple releases another generation in less than two years, some users may buy the new model hence only using their first phone for less than two years. There is no rebate or refund for the "unused portion" of an iPhone. Apple is using this accounting treatment to spread the R&D and advertising costs over time, instead of recognizing it all up front when the actual cash was spent in bringing the iPhone to market. This will allow margins to remain consistent as opposed to being lumpy. Investors will be watching the deferred revenue line and will treat it as if it were recognized revenue since there is no possibility of refunds after the first month.